Recently, there has been some talk in the market about the paper by Fed Board researcher Orphanides on ‘Monetary policy in deflation’, though many have considered it as being overtaken by events such as the past 6-months’ stronger GDP numbers. This dismissal may well prove to be premature. The work is--crucially--concerned primarily with the Fed’s ‘pre-emptive’ 1936-7 tightening (with a section also on modern day Japan) and how the line--correctly resurrected by the ECB today--that the presence of copious amounts of excess liquidity presages another Boom-Bust, was in fact nonsense, in Orphanides’ learned opinion...
This paper lays out the inflationist theory behind Bernanke and the others’ ‘slack resources’ rhetoric. I’s totally flawed, but it is very carefully crafted to appeal to the Fed’s 1920s-30s-obsessed Chairman and his vainglorious quest to go down in history as the man who faced what Strong, Harrison and Eccles did, but who got it ‘right’, not wrong. The upshot is a forceful advocacy of a policy which ignores periods of robust economic growth and signs of a shift in the attitude to prices of goods and materials, until some hypothetical full-employment, zero ‘output gap’ state has been lastingly achieved - full allowance, of course being made for the putative increase in such gaps brought about by all those supposed productivity gains (pace the BLS multifactor productivity figures which show returns even on their hedonically-adjusted and hourly under-reporting reckoning of combined labour+capital+resources use declining and even turning negative of late!).
In passing, note, too, how no-one ever seems to consider whether all the mountains of previous capital locked into sub-marginal or totally unviable, form during the prevoius Boom-phase malinvestment decreases such gaps more than commensurately. The clarion call from this paper is to keep rates as low as possible for as long as possible and to this end Orphanides even quotes Keynes approvingly in his conclusions, as follows:-
‘The remedy should come, I suggest, from a general recognition that the rate of investment need not be beyond our control, if we are prepared to use our banking systems to effect a proper adjustment of the market-rate of interest. It might be sufficient merely to produce a general belief in the long continuance of a very low rate of short-term interest. The change, once it has begun, will feed on itself. ...
‘The Bank of England and the Federal Reserve Board ... should pursue bank-rate policy and open-market operations a outrance ... [t]hat is to say, they should combine to maintain a very low level of the short-term rate of interest, and buy long-dated securities ... until the short-term market is saturated...’
These days, of course, we allow the BoJ to buy all the longer stuff, so avoiding any minor Constitutional niceties, back in the US, but the import is much the same. Given this, is there really a prospect that Greenspan will suddenly get all responsible and anti-inflationary in his Congressional testimony this week?
